Suppose you run a successful food-delivery business. Two years ago you spent $1 million on a fleet of a dozen new trucks.
On your books and tax records this year, you will subtract $200,000 from your earnings (profits) reflecting depreciation on those trucks. But you aren’t actually laying out any cash; you did that two years ago.
That’s an example of the difference between reported earnings and cash flow. Devotees say that cash flow gives a truer picture of a business’s health than reported earnings. My view: They are just different lenses through which to glimpse reality.
Here are five stocks that look good to me now, viewed through the cash flow lens.
Occidental Petroleum
News broke last week that Warren Buffett (Trades, Portfolio)’s company, Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial), has regulatory permission to increase its share of Occidental Petroleum Corp. (OXY, Financial) stock to as much as 50%.
Investing alongside Buffet is often a good strategy. He is an astute financial analyst who seems to possess wisdom and an instinctive feel for the market.
Occidental looks attractive to me at a price of about $71. It sells for about five times cash flow and six times free cash flow (which is cash flow minus the amount the company is likely to shell out for capital expenditures – in Occidental’s case, things like drilling equipment).
U.S. Steel
What, that dinosaur? Yes, United States Steel Corp. (X, Financial) looks good on a price-to-cash flow basis, selling for about two times free cash flow. Once the largest corporation in America, today it is a mere mid-sized stock.
With the Federal Reserve raising interest rates, and with many economists expecting a recession soon (some even saying it has already begun), industrial cyclical stocks are out of favor. Furthermore, the stock’s price (about $23 a share) is almost exactly where it was a decade ago.
So what earthly reason is there to buy? Simply that the stock is cheap by many measures. Over the past decade, it has commanded a median price-to-cash flow ratio of about 11; now it is 1.9.
State Street
State Street Corp. (STT, Financial) is a leading custodian for financial institutions and a major issuer of exchange-traded funds. Its stock sells for about six times free cash flow.
The bear market of 2022 has been rough on State Street: The stock is down about 18% this year. But I think its position in the financial industry is secure, and its finances are strong.
Loews
Loews Corp. (L, Financial), a conglomerate controlled by the Tisch family, is up slightly this year in a down market. It owns 89.6% of CNA Financial (CNA, Financial) (a property and casualty insurer) and 100% of Boardwalk Pipelines (BWP, Financial) (natural gas distribution), Loews Hotels and Altium Packaging.
The Tisches have a reputation as shrewd buyers and sellers of companies, but growth and profitability have been unimpressive in recent years. I like the stock mainly because it’s inexpensive, selling for five times free cash flow.
Fulgent Genetics
Fulgent Genetics Inc. (FLGT, Financial), based in Temple City, California, does genetic and medical testing for physicians and hospitals. Revenue, which was less than $33 million in 2019, climbed to nearly $1 billion last year, helped by a boom in Covid-19 tests.
Investors worry that the boom will fade, and so they award Fulgent stock only modest valuations -- less than four times free cash flow, for example. The company is close to debt-free, a quality I like.
The record
This is the 19th column I have written (starting in 1999) on stocks that look attractive based on their price relative to cash flow. The average one-year return on my previous 18 columns has been 14.6%.
That compares well with 9.5% for the Standard & Poor’s Total Return Index over the same 18 periods. Both figures take dividends into account.
Ten of the 18 sets of recommendations have beaten the index, and 12 have been profitable.
Bear in mind that my column results are hypothetical and shouldn’t be confused with results I obtain for clients. Also, past performance doesn’t predict the future.
Last year’s picks were duds. All five declined, with the worst loss being nearly 33% in Capital One Financial Corp. (COF, Financial). Argan Inc. (AGX, Financial), MarineMax Inc. (HZO, Financial) and Synchrony Financial (SYF, Financial) all fared worse than the S&P 500, which was down 4.2%.
Only Taylor Morrison Home Corp. (TMHC, Financial) beat the index, and barely so: It declined 3.2%. All in all, my 2021 picks were down 19.1%. Let’s hope this year’s crop does much better.
John Dorfman is chairman of Dorfman Value Investments in Boston. He can be reached at [email protected]. He or his clients may own or trade stocks discussed in this column.
